An extremist, not a fanatic

September 17, 2011

Everyone says Europe has a debt crisis. But does it not instead have a morality crisis?What I mean is that, technically speaking, there are lots of possible solutions to the problem, such as some mix of:- Eurobonds, either actual or synthetic, accompanied by limits upon governments‘ ability to borrow.- Recapitalizing the banks so they can withstand the inevitable write-down of PIGS’ debt.- A debt-equity swap- A German fiscal expansion- Full-blown quantitative easing, perhaps via changes to the SMP.(I do not include a breakup of the euro as a solution because it’s not; it would only be a massive default).The thing is, this range of options is pretty impressive compared to those available in most political and economic crises. Of course, they all have costs, but not technically insuperable ones.Instead, the obstacle is morality. All these options - except fiscal expansion which is only part of the solution anyway - impose costs upon northern European taxpayers. Which prompts the sort of questions posed by Clemens Wergin of Die Welt: why should German tax-payers support Greek tax-dodgers? Why should bankers who have made bad loans be bailed out? In short, there’s moral resistance, founded in part upon natural justice and in part upon the protestant bourgeois belief that hard work and prudence should be rewarded and fecklessness punished.I say this is moral resistance rather than self-interest for a simple reason. Tax-paying Germans will lose money even if policy-makers do nothing. A Greek default, and contagion losses on other PIGS’ bonds, will lead to a banking crisis and to recession in southern Europe which clobbers the German economy. Whatever happens, Germans lose. The question is whether they lose by doing nothing or by formally supporting banks and/or PIGS. Insofar as there is resistance to the latter, it is founded on morality - a desire to punish sinners - rather than narrow self-interest.Herein, I think, lies the cause of the markets’ annoyance at Europe’s lack of leadership. If you regard the crisis as a merely technical one, you’ll see lots of possible fixes - or at least improvements on the status quo - and will therefore be frustrated that these aren’t being pursued. What you miss is that moral aspect.This, though, merely raises a more general point about politics - that there is not only often a clash between moralists and technocrats, but a mutual incomprehension between them.

September 16, 2011

Responsible policy-makers should consult widely before reaching their decisions. This is trivial. It is also wrong, according to new research. A neat experiment at Nottingham University shows how consultation can be counter-productive. They got subjects to say whether a couple of paintings were by Paul Klee or Wassily Kandinsky. The subjects were split into two groups. One group comprised individuals making their own decisions. The other comprised individuals who were assigned to teams of six and allowed to consult team members.And members of the teams did worse. Whereas only 29% of individuals got both paintings wrong, a whopping 51% of team members did so - twice as many as you‘d expect by chance.There was, however, no significant difference in the proportions getting both questions right: 38% of individuals versus 36% of team members.Consultation, then, increases the chances of a bad decision, without improving the chances of a good one. What’s more, people don’t realize this; most said that they found the consultation process helpful.The reason for this is that people are misled into giving wrong answers by team members who are irrationally over-confident, because these send out more (false) competence cues. “Individuals who know little are swayed by those who know less” say the researchers. (This is more true for women than men, but let’s not go there.)There is, though, a crucial thing about this result. It all hinges upon whether the answer to a question is demonstrable or not. If it is demonstrable, then an expert who knows the answer can prove that he does so by using logic or evidence, and non-experts will defer to him. Consultation will then work, simply by virtue of bringing expertise into play. But some knowledge is non-demonstrable. The expert might be able to distinguish between Klee and Kandinsky, but he’ll find it harder to demonstrate his expertise to laymen than, say, a mathematician will be able to demonstrate that he knows the solution to an equation. And where knowledge is non-demonstrable, people might follow false experts.This, I fear, might have widespread implications. Juries, for example, are asked to find a non-demonstrable answer. It suggests that public consultation exercises must be carefully designed - or least they should, insofar as the object of them is to reach the correct decision, which might not always be the case.

September 15, 2011

One of the most unpleasant aspects of the last Labour government was the illiberalism that saw it create over 4000 new criminal offences. However, it’s becoming clear that, in this regard, Labour was merely reflecting a censoriousness culture. Take these examples:- two men were jailed for four years for (unsuccessfully) using Facebook to try to incite a riot.- The London Philharmonic Orchestra has suspended some musicians for merely writing a letter- a man has been imprisoned for trolling.To these cases we might add the disproportionately hostile reaction to Johann Hari’s activities. His sins were small compared to the crimes of, say, serial drunk-driving or being Toby Young, and perhaps indicative of a troubled mind rather than malevolence. And if you don’t like his journalism, the solution is not to make a fuss, but to not buy the Independent - a feat which 99.7% of the British people perform each day.What interests me is: why is there this intolerance? I suspect there are three separate things.One is technophobia. From Mary Shelley writing about the frightening power of electricity to people sheltering from wi-fi in West Virginia, some people have been scared by the power of new technology. Judges, who have never been comfortable with modernity, merely continue this pattern. In believing Facebook to have occult powers, they treat its misusers far more harshly than they would idiots making comparable remarks in the pub.Another thing, which applies to the Hari case, is a mix of tribalism and envy. Rightists celebrate the embarrassment of an opponent, whilst Leftists - bizarrely - envy Hari his job. Both lead to a loss of perspective.There is, though, something else which links all these cases. They corroborate my fear that we have lost the conservative disposition - the recognition that the crooked timber of humanity does bad and silly things and that we should tolerate this. In its stead is the belief that people should conform to an ideal of buttoned-up, restrained respectability. So the LPO expects - contrary to centuries of evidence - musical ability to coexist with sensible political opinions; judges expect that Facebook users will not be hotheads; and the Twitterati convinces itself that columnists should somehow have standards higher than those of mere shills. And when reality hits these silly ideas, the response is an outrage comparable to that of Victorian ladies whose delicate sensibilities have been offended.And in all this, toleration and liberty are lost.

September 14, 2011

The IFS’s claim that it is unclear whether the 50p tax rate will raise any revenue at all (pdf) has led to some iffy headlines - compare the Torygraph’s story with Paul Johnson’s actual words - and another Richard-Tim spat.I fear, though, that this is distracting us from a complication - that there is not one but three Laffer curves here. What I mean is that there are three questions we might ask of the top tax rate:- does it maximize revenue?- does it maximize GDP?- does it maximize well-being?There is no reason, a priori, to suppose that the answers to these three will coincide.For example, a tax rise might reduce revenue even if it doesn’t affect GDP if it has no effect upon labour supply but encourages people to seek legal or illegal tax dodges.Or it might reduce GDP whilst improving well-being. This would happen if the tax rise deters the sort of activity that is negative-sum for the economy as a whole. I’m thinking here of rat-races in which everyone works long hours in the hope of getting promotion; patent trolling; office politics; or spending on positional goods that have negative externalities (pdf). Which brings me to a hypothesis. It could be that the tax rate that maximizes revenue is quite low - because even a modest tax will lead to tax-dodging - but the rate that maximizes GDP is higher, and that which maximizes well-being is higher still.To focus only upon the first of these, the revenue effect, is to make a fetish of the public finances whilst ignoring the real economy.

September 13, 2011

This piece by Andrew Hill perhaps inadvertently highlights the ideological nature of management. He proclaims, reasonably enough, the merits of day-to-day progress and “small wins” within firms against “big hairy audacious goals”. But this raises the question. Why should firms focus on progress at all?Put it this way. If Lionel Messi plays as well this season as last, only a half-wit will complain that he hasn’t made progress. Instead, we’ll celebrate his consistent brilliance. Only the mediocre need “progress.” For the truly excellent, its enough to maintain a plateau.But even if we need progress, why should this be an explicit, management-directed goal? In the introduction to one of his superb guitar books, Allan Alexander says that if you keep playing, you’ll get better whether you want to or not. This speaks to the possibility that incremental improvement is something to be achieved obliquely rather than as a conscious goal. Now, you might object here that what really spurs improvement is what Matthew Syed calls purposeful practice, which requires organized feedback. True. But inserting this into companies has been difficult; there’s some evidence that employee performance reviews actually backfire and have a negative effect upon productivity. This is consistent with the theory that firms are institutionally stupid, in the sense that they are incapable of learning. Which raises a question. Could it be that the rhetoric of progress, “moving forward”, “managing change”, “driving towards objectives” and other dynamic-sounding terms serves an ideological function?I mean this in two senses, but there might be more.1. The notion of progress gives management a valuable role. In principle, we could judge management by how well organized a firm was. But by this standard, very many managers would seem inadequate (pdf). As John van Reenan and Nick Bloom show (pdf), there is a “long tail“ of poorly managed firms. The concept of progress, though, deflects attention from that management often fails whilst maintaining that there is a caste of experts who can both identify short-comings and remove them. There’s a variant of Heisenberg’s uncertainty principle here. Managers want us to focus on movement, so that we don't measure their actual position and achievement. 2. “Progress” operates to smooth over conflict. It says to workers: “you might be poorly paid and badly treated now, but things will be better in future.” It’s the White Queen’s “jam tomorrow” trick. My point here is simple. What look like neutral, technical, jargon-laded issues of management are in fact means by which power is exercised and legitimated.

September 12, 2011

Urban legend has it that when a plane is about to crash, passengers are asked to adopt the brace position not because this will save their lives, but because doing so will protect their teeth and so make it easier to identify the corpses from dental records.I was reminded of this by the Vickers’ report recommendation that retail banking be ring-fenced from investment banking. The purpose of this, as Jonathan says, is not to reduce the risk of failure. It is instead to assist the clean-up operation after failure - to make it “easier and less costly to resolve banks that get into trouble” because such relatively simple operations are easier to either unwind or sell on than investment banks with their countless counterparties and opaque assets.Instead, Vickers’ plan to reduce - not, note, eliminate - the risk of banking failure lies in the call for higher capital ratios. In themselves, these aren’t the problem; the 10% he recommends is actually slightly lower than banks have now (though any losses from the euro area debt crisis and associated economic slowdown will reduce these). There are, though, two other problems:1. Vickers calls for a further 7-10% of banks’ assets to consist of “loss absorbing” liabilities such as bail-in bonds, cocos or unsecured debt.However, given the riskiness of banks’ activities, investors will only want to hold these on Buffett-style usurious terms. This will raise banks’ costs.2. Vickers threatens the basic model of investment banking. A lot of its activities are low-margin near-arbitrage trading - hoovering up pennies. To make this profitable, you need lots of hoovers - high leverage. Which Vickers opposes.For example, last year Barclays Capital made £4.8bn profits on £191.3bn of risk-weighted assets (p46 of this pdf), a return of 2.5%. But this was in a very favourable time - near-zero borrowing costs. In 2006-07, return on RWA was just half this (p59 of this pdf). This means that if Barcap must hold 10% of its assets in equity, return on equity would be around 13% in normal times. This is in line with Bob Diamond’s target - but it shows how hard it will be to much exceed that.In these two ways, the Vickers report is a threat to the banks.But this is not a bug. It’s a feature. A major purpose of the report is to remove the implicit subsidy which governments give to banks both by offering to bail them out if they get into trouble, and by giving tax relief on debt. Vickers says:

The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers

Although Vickers estimates these subsidies to be more than £10bn a year, he estimates that his proposals will cost banks less than this: £4-7bn. In this sense, Philip Aldrick is right. Banks got off lightly. Which brings us to questions raised, but not answered, by the report:1. How much would banks be worth if the implicit subsidy did not exist? Last year, the combined profits of Barclays, Lloyds and RBS were just £10.2bn, suggesting that banks might be almost worthless without that implicit state aid. And this raises the question; if banks were of nugatory value, how on earth could they raise sufficient capital from the private sector to provide the loss absorption which Vickers wants? There is a trade-off between reducing the tax-payers' exposure and increasing banks' loss-absorbers.2. How much do the Tories really believe in the Thatcherite virtues of self-reliance and standing on your own two feet? If they did, their only quibble with Vickers would be that he doesn’t quite go far enough. Which doesn't seem to be the case.

September 11, 2011

Imagine a dictator were to allocate jobs and positions of power, with the best ones given to people deemed talented and virtuous, whilst those deemed to be stupid, criminal or “feral“ were condemned to drudge work of life on subsistence benefits. Imagine further that although the dictator claims that these judgments were based upon the hard evidence of exams and school reports, he in fact gives the best positions to those he favours. What, then, would be our attitudes to equality?I reckon three things would happen:1. People will tolerate such inequalities, because:- The hindsight bias would lead people to believe that “top people” must have done something to justify their success- The just world fallacy will lead people to seek reasons for inequality- The “Deal or No Deal effect” or apophenia (our urge to see patterns in arbitrary events) will lead us to under-rate the importance of the dictator’s whims and instead see some desert and inevitability in the equality.- Given these predispositions towards tolerating equality, a mix of the confirmation bias and framing effects will further support inequalities. Any good or wise conduct of the rich and powerful will be interpreted as justification for their fortune, whilst incompetence and corruption will be seen as isolated incidents.One fact tells us that effects such as these are powerful - that unjust societies rarely experience revolutions solely because of inequality, and indeed can persist for decades. It is poverty or lack of freedom, rather than inequality alone, that triggers unrest. 2. These inequalities, though ex hypothesi arbitrary and unjust will come to be correlated with merit. People assigned to good jobs will appear to be smart, whilst those deemed criminal or stupid will live down to their reputations. Norm suggests one reason for this. If you give people jobs that require articulacy and intelligence, such people will cultivate articulacy and intelligence, and so appear more meritorious than people in drudge work whose intellectual capacities atrophy through under-use.There is, though, another reason. Labelling theory and stereotype threat tell us that people come to adopt the identities they are allocated; as the saying goes, “give a dog a bad name”. The most famous example of this was the Stanford prison experiment. But there are others:- Students who are reminded of their athletic abilities do worse (pdf) on academic tests than people of similar abilities who are not so primed. - Older workers can be less productive precisely because they are labelled as has-beens.- Women who are reminded of their gender become less competitive than others.- The Oak school experiments show that pupils who were arbitrarily deemed to have high IQs go on to do better on genuine tests.3. Given point (2), inequalities will become further legitimated, because they’ll become seen to be correlated with differences in ability.There are (at least) two points here. First, public support for inequality is no evidence of the legitimacy of that inequality, as it can arise through cognitive biases. Secondly, meritocracy, in itself cannot justify inequality because it might be, to some extent, the result of inequality rather than the cause.

September 09, 2011

In the day job, I say that gold’s rise has enriched some very silly people, and a reader replies that he wishes he had been even sillier. This highlights the fact that being right is no evidence of being rational. The point here is not merely Ecclesiates’ one, that riches don’t go to men of understanding because time and chance happeneth to us all. It’s that irrationality might actually be necessary for success. As a higher authority than the Bible said, “no great thing has ever been accomplished without somebody's crazy belief."The example of gold shows this. The man who, who a few years ago expected hyperinflation and/or full-blown debt crises in the UK and US would have piled into gold and made a packet by now - much more, in fact, that the less idiotic investor who took a more cautious position.This is not the only example. Irrationally overconfident people are more likely to be promoted, because others mistake their overconfidence for real ability. And, indeed, irrational overconfidence is necessary to motivate people to enter risky jobs such as sports, politics, the arts or entrepreneurship. As Richard Nisbett and Lee Ross said in one of the earliest works on cognitive biases:

We probably would have few novelists, actors or scientists if all potential aspirants to these careers took action based on a normatively justifiable probability of success. We might also have few new products, new medical procedures, new political movements or new scientific theories.

All this should be well-known. But here’s my concern. What if this selection for irrationality combines with a form of hindsight bias in which people attribute wisdom to the successful? We will then give too much credence to the idiotic investor who over-weighted gold for barmy reasons, to the boss who won promotion by being irrationally overconfident, to the politician who won power by unreflectingly articulating the prejudices and idiocies of his colleagues and the public, or to the novelist or entrepreneur who just got lucky. The bland or foolish thoughts of the rich and successful will be lauded, whilst the interesting ideas of the more obscure will go unnoticed. We will then celebrate irrationality.I fear this might explain a lot of editorial decisions at the BBC and in the print media.

September 08, 2011

1. Will the 50% rate actually raise revenue?2. Is it moral for the government to take 50% of an individual's marginal effort?

My answer to (1) is: I don’t know, and nor does anyone else. There’s huge uncertainty on the behavioural response to higher taxes. All we can say, for now, is that data on house prices, FDI, emigration and the movements of Premiership footballers suggest that fears of a mass exodus of workers or investors seem - so far - to have been wrong, which corroborates the evidence (pdf) from a tax rise in New Jersey.My answer to (2) is: yes, for three reasons*. First, an individual is usually free to expend marginal effort - to work harder or to take a higher-paid job. This being so, he chooses to pay that 50%. In this sense, a high marginal tax is more moral than a high average tax; most of us are compelled to work, but we are not compelled to earn more than £150,000pa.Secondly, a high marginal tax on high incomes can be seen as a form of insurance payment. If we were behind a veil of ignorance - not knowing our skills or demand for them - we might well agree some kind of insurance, in which the low-skilled get a payout whilst the high-skilled or lucky pay a premium. Most risk-averse people, I guess, would think it reasonable to pay extra if you’re in the top 1% of earners in exchange for income support in the much higher probability event of being disabled or unskilled. (It's this sort of thinking that lies behind the slogan that the 50p rate is "fair").From this perspective, the objection to a 50% tax rate is not so much that it’s too high, but rather that it is insufficiently used to insure folk against bad outcomes.Thirdly, there are circumstances in which we agree that it’s right for the government to take 100% or more of an individual’s marginal effort. If a man works an extra hour a day burgling houses or mugging people, we’d expect the state to take all the fruits of that labour. And some high-paid work is similar to robbery, in the sense that it’s zero- or negative-sum activity. The banker who takes high risks knowing that he’ll get a bail-out if he loses, the middle manager who spends his time on office politics and sucking up to his boss, the manager who exploits his workers, patent trolls, (some) libel lawyers or lobbyists campaigning for special favours or regulations are all making money at others’ expense. It is, surely, entirely reasonable for the state to seize the proceeds of such activity and to deter them.Herein lies a difference between left and right. Whereas the left see the rich as mainly greedy exploiters, the right see them as public benefactors. I don’t know which side is more right. Which brings me to a problem. Nor does the tax system. It treats the incomes of Fred Goodwin or Keith Schilling in the same way as those of James Dyson, Morrissey or Jack Wilshire. Money earned at others’ expense is treated the same way as money earned whilst increasing social welfare. In this sense, there is an element of horizontal inequity about the 50p tax rate. For me, this means that inequality cannot be tackled through the tax system alone. There must be other institutions in place which penalize zero- or negative-sum activity. (Clue - workers’ ownership). One reason why I’m not a social democrat is that social democracy has, generally, failed to see this. * Millions of low-paid people have for years faced withdrawal rates of far more than 50%, because they lose in-work benefits as their wages rise. I ignore this.

September 07, 2011

Some economists say the 50p tax rate “is doing lasting damage to the UK economy.” I’m not sure I agree. As Richard and Duncan say, the economists provide no strong evidence for this. Their concerns that the rate is “making us less attractive as a destination for both foreign investment and talented workers” certainly don’t jump out of the data. Emigration actually fell last year, prime London house prices are rising and in the year after April 2010, there was £40bn of FDI into the UK - bang in line with the average for 2001-05*.There’s another data point which seems to contradict those economists. This is that in the 22 years we had a 40p top tax rate, UK GDP growth averaged just 2%. That compares to the 2.5% growth we had in the previous 22 years - a time when the top tax rate hit 83% on earned income. Granted, there are countless other things that affect growth. But many of these are things that supporters of low top taxes would expect to have boosted growth after 1988, such as weak trades unions and the absence of the wage and price controls we had in the 70s.Of course, these facts don’t settle the matter. But they do draw attention to a possibility - that low top tax rates do not obviously promote growth, and might even retard it.There are three reasons for this:1. Low taxes have ambiguous effects on labour supply. Yes, they increase the returns to work, thus making work more attractive. But they also increase post-tax incomes, thus making leisure attractive. One effect of the cut in taxes in 1988, for example, was to allow older investment bankers to take early retirement in the 90s and 00s. Empirically, it’s not clear which effect dominates2. Insofar as low tax rates do encourage greater work effort, this needn’t be productive. Low tax rates encourage greater competition for senior jobs, which might divert effort away from productive labour and towards rent-seeking and office politics and might encourage a “yes-man“ mentality that leads to groupthink and poor decisions. Or they might encourage excessive risk taking and speculation, which ends in a financial crisis.3. Even if some people do stop productive work as a result of higher taxes, the loss is often second order. Imagine a good CEO were to quit because taxes were too high; you‘ll have to imagine it because, AFAIK it hasn‘t actually happened. The firm would hire a replacement. The loss of GDP would be the difference between the CEO’s managerial ability and that of his successor, which will probably be small. I fear that advocates of low top taxes subscribe to some Randian “great man” theory of economic growth, in which prosperity is driven by a few stars. But this is questionable. If it were true, we’d expect firms who lose CEOs to high taxes to announce their replacement by saying: “This guy’s not as good as his predecessor; you should revise down your earnings estimates.” This doesn’t happen. I don’t say this to asset that higher top taxes are definitely a good thing, merely to point out that both theory and evidence are more mixed than those economists who wrote to the FT say. As IFS researchers say (pdf) there is “considerable uncertainty” about the effect of top taxes. My suspicion is that they won’t much affect growth either way, simply because so few policies do, especially those that affect only a tiny minority.Which brings me to my biggest complaint against those economists. To worry so much about the 50p tax rate at a time when real incomes are being squeezed, unemployment is rising and some benefit claimants face real hardship is to display a rather warped set of priorities. * Yes, FDI is sharply down from 2005-07, but that was the peak of a boom/bubble.